Harman International: Has David Einhorn's Thesis Already Played Out?

The research team of The Manual of Ideas recently profiled a new holding of David Einhorn's Greenlight Capital. The analysis follows:

BUSINESS OVERVIEW

Harman International (HAR) provides high fidelity audio products and electronic systems. The company operates in three segments: Automotive provides audio, electronic and infotainment systems to be installed as original equipment by auto makers. Consumer provides audio, video and electronics for home, mobile and multimedia. Products are sold through retailers such as Circuit City, Best Buy, MediaMarkt and Fnac. Professional provides loudspeakers and electronic systems used by audio professionals in concert halls, stadiums, airports, houses of worship, and theme attractions.

INVESTMENT HIGHLIGHTS

• Owns renowned brands JBL, Infinity, Harman/ Kardon, Mark Levinson, and Becker. It is a leader in integrated infotainment for the auto industry.
• Growth opportunities exist in all three segments: (1) automotive: potential to increase number of models offering Harman systems and to increase per-vehicle content of premium branded audio; (2) consumer: may benefit from convergence of home and multimedia technologies (offers branded accessories for iPod and iPhone); (3) professional: proprietary HiQnet system protocol incentivizes users to purchase complete compatible systems.
• Targeting $400 million of annualized savings by FY11, of which $150 million have been realized. Total after-tax savings would amount to $4/share.
• Mid-Infotainment system launch expected in fall 2009, ahead of original target. The company has been gaining share via new product introductions. China capacity has been doubled with a new plant.
• Dinesh Paliwal (50) became chairman and CEO in July 2008. He was previously CEO of ABB North America. Herbert Parker (50) joined as CFO in June 2008. He was previously also at ABB N.A.
• According to Greenlight Capital, Harman “could earn over $2 per share within the next couple of years, and much more in a normal environment.”
• Shares trade at .3x LTM revenue, 1.3x tangible book.
  

INVESTMENT RISKS & CONCERNS

• Weak end markets in CQ1 2009, with global, U.S., European and China/India auto production down 38%, 56%, 41%, and 17%, respectively. Consumer and professional markets are also weak.
• Debt of $662 million, partially offset by cash of $334 million. Debt appears manageable, as earliest maturity not until the end of 2011. $400 million convert carries 1.25% coupon and matures in 2012.
• Customer concentration. Daimler made a strategic decision in 2006-07 to move to dual sourcing, causing Harman’s share of Mercedes business to decline in FY08 and again in FY09. The business should stabilize at a “substantial” level in FY10.
• CEO received total comp of $17 million in FY08.
  

MAJOR HOLDERS

Insiders 1% │ Cap Re 12% │ Cap World 9% │ Greenlight 6% │ Relational 6% │ T Rowe 6% │ Elm Ridge 3%

THE BOTTOM LINE

Harman occupies a strong competitive position in high-end audio products primarily for automotive applications. When the auto industry return to “normal,” Harman appears likely to reestablish profitability of several dollars per share. However, we view future earning power as too uncertain to warrant a meaningful multiple of projected earnings. We note that David Einhorn’s Greenlight Capital established its position at $11.07 per share, significantly below the recent market price.

SELECTED OPERATING DATA

FYE June 30	2006	2007	2008	YTD 3/31/09
% of revenue by segment:
Automotive	69%	70%	72%	70%
Professional	16%	16%	15%	16%
Consumer	15%	14%	13%	14%
Revenue growth by segment:
Automotive	5%	11%	19%	-28%
Professional	6%	8%	9%	-20%
Consumer	18%	1%	7%	-28%
Change in revenue	7%	9%	16%	-27%
Change in headcount	4%	4%	0%	-14%
EBIT margin by segment:
Automotive	15%	14%	5%	-4%
Professional	11%	14%	16%	12%
Consumer	10%	3%	-1%	-11%
Unallocated and other	-2%	-1%	-2%	-2%
Total EBIT margin	12%	11%	4%	-4%
Selected items as % of revenue:
Gross profit	35%	34%	27%	24%
SG&A	23%	23%	24%	28%
EBIT	12%	11%	3%	-19%
D&A	4%	4%	4%	5%
Capex	4%	5%	3%	3%
% of revenue by geography:
Germany	44%	45%	42%	n/a
Other Europe	18%	18%	16%	n/a
U.S.	22%	21%	23%	n/a
Other regions	17%	16%	18%	n/a
% of revenue by major customer:
Daimler and Chrysler 1	23%	23%	18%	16%
Audi / VW	9%	10%	11%	15%
BMW	10%	<10%	<10%	14%
Return on tangible equity	33%	32%	11%	-8%
Tang. equity to assets (avg)	41%	47%	44%	36%
Change in shares out (avg)	-1%	-1%	-6%	-6%

Source: Gridstone Research, Company filings, Manual of Ideas analysis.

¹ Standalone Chrysler accounted for 7% of revenue YTD 3/31/09.

APPENDIX: OVERVIEW OF FACILITIES USED IN COURSE OF BUSINESS

	Seg-	Size		Utilized
Location	ments1	(Sq. Ft.)	Util.	Sq. Ft.
Owned Properties – U.S.
Elkhart, IN	P	223,000	86%	191,780
Martinsville, IN	A	221,000	40%	88,400
Franklin, KY	A	152,000	96%	145,920
Washington, MO	A	101,000	100%	101,000
		697,000	76%	527,100
Owned Properties – International
Suzhou, China	A	145,000	50%	72,500
Chateau du Loir, France	A, C	221,000	75%	165,750
Ittersbach, Germany	A	565,000	100%	565,000
Straubing, Germany	A	235,000	100%	235,000
Worth-Schaidt, Germany	A	204,000	100%	204,000
Szekesfehervar, Hungary	A	117,000	100%	117,000
		1,487,000	91%	1,359,250
Total Owned Properties	2,184,000	86%	1,886,350
Leased Properties – U.S.
Moreno, CA	C, P	301,000	100%	301,000
Northridge, CA	A, C, P	589,000	82%	482,980
Rancho Cucamonga, CA	P	212,000	100%	212,000
Atlanta, GA	C	635,000	100%	635,000
Sandy, UT	P	127,000	100%	127,000
		1,864,000	94%	1,757,980
Leased Properties – International
Vienna, Austria	P	193,000	100%	193,000
Juarez, Mexico	A	109,000	100%	109,000
Tijuana, Mexico	C, P	198,000	78%	154,440
Regensdorf, Switzerland	P	108,000	93%	100,440
Bridgend, U.K.	A	168,000	100%	168,000
Potters Bar, U.K.	P	160,000	100%	160,000
		936,000	95%	884,880
Total Leased Properties	2,800,000	94%	2,642,860

Source: Harman 10-K, Manual of Ideas analysis.

¹ A = automotive, C = consumer, P = professional.

Disclosure: No position.